What Is an Alabama Catastrophe Savings Account?

An Alabama Catastrophe Savings Account (CSA) is a specialized savings vehicle designed to help homeowners prepare for the financial impact of natural disasters. It is a tax-advantaged account available to eligible Alabama residents, allowing them to set aside funds for covering insurance deductibles and other related costs from a catastrophic event. The primary purpose of this account is to encourage proactive financial planning for severe weather events, such as hurricanes and floods, which can cause damage to residential properties.

Establishing an Alabama Catastrophe Savings Account

To open a Catastrophe Savings Account, an individual must be an Alabama resident who owns and occupies a single-family dwelling as their legal principal residence. The account itself must be a regular savings or money market account held at a financial institution and explicitly labeled as a “Catastrophe Savings Account” in the institution’s records to qualify for the associated tax benefits. Married taxpayers filing a joint return are entitled to establish one CSA for their shared principal residence.

For individuals with a standard homeowner’s insurance policy, the contribution limits are tied directly to the policy deductible. If the deductible is $1,000 or less, the account holder can contribute up to $2,000. For policies with a deductible greater than $1,000, the contribution is limited to the lesser of either $15,000 or twice the amount of the policy deductible. For individuals who are self-insured, the law allows for a contribution up to the lesser of $250,000 or the value of their legal residence.

The amounts deposited into the account are deductible from the individual’s Alabama state gross income for the year the contribution is made. It is important to note that this is a state-level tax deduction and does not apply to federal income taxes. Any interest income earned on the funds within the CSA is also exempt from Alabama state income tax, allowing the account to grow tax-free at the state level.

Proper Use of Account Funds

They can be withdrawn without tax or penalty to pay for “qualified catastrophe expenses.” These expenses are defined as costs incurred to cover an insurance deductible for damage to the principal residence resulting from a hurricane, flood, or other catastrophic windstorm event as defined by an insurance policy. The funds can also be used for other uninsured losses that are a direct result of the same catastrophic event.

Account holders should retain all documentation related to the disaster and subsequent repairs. This includes copies of insurance claim filings, receipts for repairs, invoices from contractors, and any other records that substantiate the expenses were directly related to the catastrophe. After making a qualified withdrawal, the account balance may be replenished up to the maximum contribution limit, and a deduction can be taken for the new contributions.

Handling Non-Qualified Withdrawals and Account Closure

Any amount withdrawn for a non-qualified purpose must be included as income on the account holder’s Alabama state tax return for the year of the withdrawal. This means the withdrawn funds, including any interest or investment income that has accrued in the account, become subject to state income tax.

Beyond the income tax liability, non-qualified withdrawals are also subject to an additional penalty. A penalty of 2.5% of the withdrawn amount is levied on top of the regular income tax.

The same rules apply if an account holder decides to close their Catastrophe Savings Account. If the account is closed and the balance is withdrawn for any reason other than to cover qualified catastrophe expenses, the entire transaction is treated as a non-qualified withdrawal. Consequently, the full balance of the account, which includes all original contributions and any accumulated earnings, will be subject to both Alabama state income tax and the 2.5% penalty.